Commentary and musings on the complex, fascinating and peculiar world that is securities regulation

Friday, August 09, 2013

House Legislation Would Stiffen Penalties for High Frequency Trading

A bill introduced in the House would empower federal regulators to tap the brakes on some High Frequency Trading (HFT) practices where they pose a threat to market integrity or to companies seeking to use the futures markets to hedge business risks. The legislation would give the CFTC the power to put in place some common sense rules of the road that are aimed at controlling excesses that have occurred in connection with this kind of trading.

The Protection from Rogue Oil Traders Engaging in Computerized Trading (PROTECT) Act, HR 2292, would authorize the CFTC to issue regulations on HFT in the commodity futures markets. Earlier this year, Rep. Markey called on the SEC to use the Market Reform Act of 1990 to oversee HFT in the stock markets. The Market Reform Act authorized the SEC to prohibit or limit practices which result in extraordinary levels of volatility. The SEC is currently considering using this and other authorities to strengthen oversight over HFT trading of stocks, noted Rep. Markey, meanwhile his bill would give the CFTC new authorities to take similar actions in the futures markets.

The PROTECT Act would require traders involved in HFT in commodities to register with the CFTC and to establish trading safeguards. The Act would ban simultaneous buy and sell orders by traders using HFT in commodities. The CFTC would be authorized to set business standards to limit fraud, manipulation, and other disruptive practices in HFT.

Similarly, the CFTC would be authorized to fine HFT traders based on the amount of time of their violation. For example, a trader violating the regulations for more than a second or two could receive a higher fine than one violating a regulation for just a microsecond. In addition, penalties for market manipulation would be increased from $140,000 to the greater of $1,000,000 for individuals and $10,000,000 for entities, triple the monetary gain to the actor, or triple the total amount of proximate losses. Thus, a high frequency trader causing $100,000,000 in damages via manipulation could be fined up to $300,000,000.

Through HFT, he noted, traders are able to buy and sell stocks and futures at microsecond speed using automated systems that have the ability to destabilize markets. The Executive Director of Financial Stability at the Bank of England estimated in 2010 that HFT firms account for 70 percent of all trading volume in U.S. equities, noted Rep. Markey, and HFT is believed to have represented more than 50 percent of global futures trading volume in 2011.

Similar trading practices have now spread to oil and other commodities markets. On September 17, 2012, oil futures plummeted and recovered over the course of a few minutes. According to Rep. Markey, it is believed that HFT played a role in this flash crash market occurrence.The legislation establishes safeguards which he believes would help protect investors and the financial markets against the potential dangers of HFT in commodities and futures markets.